The Hedge Fund Law Report

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By Topic: Cherry Picking

  • From Vol. 9 No.36 (Sep. 15, 2016)

    Former SEC Asset Management Unit Co-Chief Describes the Agency’s Focus on Conflicts of Interests and Increased Efforts to Crack Down on Private Fund Managers 

    Julie M. Riewe, a partner at Debevoise & Plimpton and the former Co-Chief of the Asset Management Unit of the SEC’s Division of Enforcement, spoke with The Hedge Fund Law Report about the SEC’s recent enforcement efforts. The discussion centered on the SEC’s focus on conflicts of interest, including its targeting of horizontal allocations between funds and use of analytics to identify the improper cherry-picking of trade allocations. Riewe also explained the SEC’s decision to increase its personnel dedicated to uncovering violations of private fund managers. Riewe will be speaking at the Tenth Annual Hedge Fund General Counsel and Compliance Officer Summit, hosted by Corporate Counsel and ALM, in New York City on September 28-29. Click here for more information and to register for the Summit, using the HFLR’s promotional code available in this article for a discount of $200 off the registration price. For additional insight from Riewe, see “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); and “SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest” (Apr. 23, 2015). For more on conflicts of interest, see “Proper Use of Advisory Committees by Private Fund Managers May Mitigate Conflicts of Interest” (Dec. 17, 2015); and “Appropriately Crafted Disclosure of Conflicts of Interest Can Mitigate the Likelihood of an Enforcement Action Against an Investment Adviser” (Oct. 15, 2015).

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  • From Vol. 9 No.2 (Jan. 14, 2016)

    Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities

    A panel of current and former regulators at PLI’s recent Hedge and Private Fund Enforcement & Regulatory Developments 2015 event offered perspectives on the SEC’s focus on issues relating to conflicts of interest, valuation and fees and expenses in the private funds space; implications of the seminal Second Circuit insider trading decision in U.S. v. Newman; the DOJ’s focus on prosecution of individuals; enforcement efforts of the New York State Attorney General; and the role of whistleblowers in enforcement. The program, entitled “Current Hedge and Private Fund Enforcement Priorities – The Enforcers’ Perspective,” was moderated by Gibson Dunn partner Barry R. Goldsmith and featured Julie M. Riewe, Co-Chief of the Asset Management Unit of the SEC Division of Enforcement; Maria E. Douvas, a former federal prosecutor and a partner at Paul Hastings; Katherine R. Goldstein, an Assistant United States Attorney for the Southern District of New York and Chief of its Securities and Commodities Fraud Task Force; and Chad Johnson, Chief of the Investor Protection Unit of the New York State Attorney General. This article summarizes the key takeaways from the presentation. For additional insight from Riewe, see “SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest” (Apr. 23, 2015); and “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015). For coverage of similar discussions from PLI’s 2014 event, see “Regulators from the SEC, CFTC and New York Attorney General’s Office Reveal Top Hedge Fund Enforcement Priorities”: Part One of Four (Dec. 4, 2014); and Part Two of Four (Dec. 18, 2014).

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  • From Vol. 7 No.36 (Sep. 25, 2014)

    Hedge Fund Adviser Structured Portfolio Management Settles SEC Charges Relating to Improper Trade Allocations and Investor Disclosures

    Registered investment adviser Structured Portfolio Management, L.L.C. and two affiliated investment advisers have agreed to settle SEC charges stemming from allegedly inadequate compliance policies and procedures that resulted in improper trade allocations among the funds they advised and failure to disclose a change of strategy to fund investors.  For more on SPM, see “Dispute between Structured Portfolio Management and Jeffrey Kong Offers a Rare Glimpse into the Compensation Arrangements between a Top-Performing Hedge Fund Management Company and a Star Portfolio Manager,” The Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011).  “Cherry picking” of trades, and the conflicts of interest that arise when advisers allocate trades, have been ongoing focus areas for the SEC.  See, e.g., “SEC Charges Hedge Fund Manager and Its Founder with Securities and Investment Adviser Fraud Based on ‘Cherry Picking’ of Trades,” The Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).

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  • From Vol. 7 No.30 (Aug. 7, 2014)

    “Best Ideas” Conference Presentations: Challenges Faced by Hedge Fund Managers Under Federal Securities Law (Part One of Two)

    “Best ideas” conferences are events at which investment experts – often including hedge fund managers – make individual presentations or participate in panel discussions during which they share investment ideas, analysis and recommendations with fellow contributors and attendees.  Frequently, these conferences are organized for both educational and charitable purposes, and the net proceeds are donated to one or more non-profit organizations.  Managers who participate in these events likely do so for a variety of reasons: benefitting a particular charity, raising awareness of the attributes or shortcomings of a particular investment, sharing in the opportunity to participate in an exchange of insights with other leading professionals and demonstrating their research and/or analytical skills.  Naturally, information shared at a “best ideas” conference is available to anyone who attends.  Tickets are usually offered for sale on an unrestricted basis to the general investing public via an organizer’s website.  Accordingly, there are generally no controls over who will and will not be in attendance when information is presented.  Additionally, comments and statements made by presenters and panel members are often live-tweeted during the presentation or summarized by bloggers shortly after the presentation is concluded.  Finally, many organizers publish materials used by presenters – such as PowerPoint slides and graphs – to their websites during or soon after a conference has ended.  As a result, the information and materials that a manager prepares for the conference audience generally finds its way to a much broader, and potentially less sophisticated, consumer market.  The porous nature of this process raises a range of issues of concern for a hedge fund manager, from potential violations of general solicitation restrictions under Regulation D of the Securities Act of 1933, as amended, to compliance with antifraud and fiduciary duties under the Investment Advisers Act of 1940, as amended.  In a two-part guest article series, S. Brian Farmer, Co-Managing Partner of the Investment Management & Private Funds Practice Group at Hirschler Fleischer, and co-author John C. C. Byrne, II, identify the primary legal concerns raised by presentations at best ideas conferences and discuss how to address those concerns.  This article is the first in the series.

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part Two of Two)

    For a hedge fund manager to stand out in a crowded capital raising environment, its marketing must be lucid, coherent, consistent, credible and compelling.  The core purpose of hedge fund marketing is to convey the manager’s sustainable competitive advantage, and in doing so, managers typically find case studies persuasive.  If properly structured, case studies can demonstrate how a manager achieved reported results rather than merely communicating what those results were.  That is, a good case study can help substantiate a manager’s claim to competitive advantage, while at the same time illustrating the sustainability of the advantage.  However, the use of case studies by hedge fund managers in marketing is constrained by law and regulation, some of it counterintuitive to a logical portfolio manager.  For example, if a marketing presentation describes a successful investment with 100% accuracy, that presentation may nonetheless be materially misleading under the federal securities laws.  In short, case studies have obvious business value, but sometimes non-obvious legal risk.  This article is the second in a series seeking to untangle that risk for hedge fund managers that wish to capture the upside of case studies in marketing.  This article continues the discussion of risks associated with use of case studies (initiated in the first article in this series), and provides five best practices for managers wishing to use case studies in marketing.  The first article in the series described the purposes and typical contents of case studies; identified the types of managers and strategies that use and benefit from case studies; and began the discussion of risks associated with use of case studies in marketing, including an analysis of the cherry picking rule.  See “How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 46 (Dec. 5, 2013).

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  • From Vol. 6 No.46 (Dec. 5, 2013)

    How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule? (Part One of Two)

    Hedge fund due diligence is a courtship process in which institutional investors and their consultants spend considerable time and resources getting to know a manager’s philosophy, people, processes and performance.  See “Getting to Know the Gatekeepers: How Hedge Fund Managers Can Interface with Investment Consultants to Access Institutional Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).  Headline performance numbers (phrased gross or net of fees), statements of strategy and similar routine and comparable data points are necessary but not sufficient to tell a manager’s story, or to convey what is unique in the manager’s value proposition.  See “Can Hedge Fund Managers Use Gross (Rather Than Net) Results in Performance Advertising? (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 42 (Nov. 1, 2013).  Investment and operational due diligence focus not only on what performance the manager achieved, but also on how the manager achieved that performance.  And there is no more comprehensive or persuasive way to convey the “how” of a manager’s processes than to walk investors step-by-step through the lifecycle of actual investments – in other words, to present case studies.  However, the instinct of managers (and their marketing and sales people) to put their best feet forward when presenting case studies is constrained by general and specific prohibitions in the federal securities laws and rules.  Generally, the federal securities laws and rules prohibit materially misleading statements or omissions in communications with investors and potential investors.  Applied to case studies, this general prohibition typically means that managers cannot discuss good investments without also discussing bad investments.  Specifically, Rule 206(4)-1(a)(2) under the Investment Advisers Act of 1940 (Advisers Act) – the so-called “cherry picking” rule – prohibits a manager from disseminating, directly or indirectly, advertisements that refer to specific past profitable recommendations unless the advertisement offers to provide a list of all of the manager’s recommendations for at least the past year.  In short, managers often have a compelling business rationale for telling their stories via case studies (and likely will have more opportunities to do so now that the JOBS Act rules have been finalized), but managers’ ability to present case studies is constrained by a patchwork of law and regulation.  See “A Compilation of Important Insights from Leading Law Firm Memoranda on the Implications of the JOBS Act Rulemaking for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 6, No. 30 (Aug. 1, 2013).  This article is the first in a two-part series designed to untangle that patchwork and enable managers to market via case studies within the scope of applicable authority.  In particular, this article describes the purposes and typical contents of case studies; identifies the types of managers and strategies that use and benefit from case studies; and highlights risks associated with use of case studies in marketing, including a discussion of the cherry picking rule.  The second article in the series will discuss additional risks of using case studies and provide best practices for managers wishing to use case studies in marketing.

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  • From Vol. 6 No.1 (Jan. 3, 2013)

    SEC Charges Hedge Fund Manager and Its Founder with Securities and Investment Adviser Fraud Based on “Cherry Picking” of Trades

    The SEC has clearly communicated its commitment to scrutinizing how hedge fund managers are identifying and managing conflicts of interest specific to their businesses.  See, e.g., “Davis Polk ‘Hedge Funds in the Current Environment’ Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  One of the conflicts most commonly cited by the SEC is the fair and equitable allocation of investment opportunities by a hedge fund manager among its clients and proprietary accounts.  The SEC’s concern with conflicts raised by allocations has been emphasized in speeches, letters and compliance outreach programs; and is evidenced by an enforcement action recently commenced by the SEC against an investment advisory and hedge fund management firm and its principal.  This article summarizes the allegations, charges and relief sought in the SEC’s complaint.  See also “How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?,” The Hedge Fund Law Report, Vol. 4, No. 19 (Jun. 8, 2011).

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  • From Vol. 4 No.19 (Jun. 8, 2011)

    How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?

    All hedge fund managers that manage multiple funds and accounts – which is to say, the vast majority of hedge fund managers – have to draft, implement and enforce policies and procedures governing the allocation of trades among those funds and accounts.  Where those funds and accounts follow explicitly different strategies, the appropriate approach to allocations is relatively straightforward.  For example, if a manager manages an equity long/short fund and a credit fund, equities go to the equity fund and bonds go to the credit fund.  But where multiple funds and accounts may be eligible to invest in the same security, the appropriate approach to allocations is more challenging.  For example, if a manager manages an equity long/short fund and an activist fund and purchases a block of public equity, how and when should the manager determine how to allocate the block between the two funds?  While the specifics of an allocations policy will depend on the manager’s fund structures and strategies, some general principles and proscriptions apply.  As for principles, an allocations policy should be equitable, should take into account the size and strategies of various funds, should provide a mechanism for correcting allocation errors and should give the manager an appropriate degree of discretion in making allocation determinations.  As for proscriptions, the boundaries of “appropriate discretion” in this context generally are set by the anti-fraud provisions of the federal securities laws and principles of fiduciary duty.  In other words, you cannot allocate trades in a manner that constitutes securities fraud.  How might trade allocations constitute securities fraud?  A recent SEC order (Order) answers that question; and a prior criminal indictment (Indictment, and together with the Order, the Charging Documents) and plea arising out of the same facts raises the frightening prospect that in more egregious circumstances, fraudulent trade allocation practices may constitute criminal securities fraud.  This article explains the facts and legal violations that led to the Order, Indictment and plea, then discusses the implications of this matter for hedge fund managers in the areas of trade allocations, marketing, disclosure on Form ADV and creation and maintenance of books and records.  In particular, this article discusses: why the cherry-picking scheme at issue in this matter was not just a bad legal decision, but also a bad business decision; two types of cherry-picking; whether and in what circumstances cherry-picking may lead to criminal liability; how the sometimes purposeful vagary of criminal indictments can subtly expand the reach of white collar criminal liability; whether disclosure can cure trade allocation practices that are otherwise fraudulent; the compliance utility of technology; conflicts of interest inherent in one person serving as chief compliance officer and in other roles; whether post-trade allocations are ever permissible; how hedge fund managers can test the sufficiency of their trade allocation policies; how trade allocation policies interact with the transparency rights sometimes granted to larger hedge fund investors; and the idea of “cross-fund transparency.”

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  • From Vol. 1 No.26 (Dec. 3, 2008)

    SEC Cuts Back on Anti-Cherry Picking Rules

    On November 7, 2008, the SEC’s Division of Investment Management issued a no-action letter to The TCW Group Inc. indicating that the division will not recommend enforcement action if wholly-owned investment advisory subsidiaries of TCW distribute marketing materials to prospective and current clients where the materials highlight certain portfolio investments and contain other analytical information, so long as TCW complies with conditions designed to prevent subjectivity and misleading cherry-picking of results.  We explain how this no-action letter may expand the range of investment-specific information that hedge fund managers may communicate to investors.

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  • From Vol. 1 No.22 (Oct. 10, 2008)

    SEC Charges Hedge Fund Adviser With “Cherry Picking”

    On September 9, 2008, the Securities and Exchange Commission filed a civil complaint in the United States District Court for the Southern District of New York charging James C. Dawson, an individual investment adviser, with securities fraud and investment adviser fraud.  The SEC’s complaint alleges that Dawson, the investment adviser and sole general partner of an unregistered hedge fund, carried out a scheme in which he “cherry-picked” profitable trades for his own account, thereby harming his clients and unjustly enriching himself at their expense.

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